China is no economic miracle or superpower

A few days after Sept. 11, 2001, a Chinese businessman was interviewed about the events of that day. In broken English, he said something along the lines of, "9/11 bad, but good for business."

The man, a flag manufacturer, was making US flags that US citizens were clamoring to display after the attack on their country. His remark was innocent enough and didn't get much attention. Even though China had a global presence, it still seemed distant and mysterious, and it's opinion on matters of importance to US policymakers was not considered crucial.

That all changed two months later, when China joined the WTO. Some observers greeted this development with exuberance, others with alarm and yet others with casual curiosity. Regardless, it seemed to confirm what many had quietly been saying since the early 1990s: China had stepped onto the world stage.

Fast forward to this year: Everybody is intensely curious about China and almost everybody in the West -- especially in the US -- is concerned. Why? Because of CNN's Lou Dobbs. Well, not really. But he does talk about one of the US' biggest fears: that jobs are going to China.

The rationale for this concern is pretty straightforward. Basic economics says that if a company wants to make a buck, it should go abroad in search of the lowest wages. China has an abundance of cheap labor, the argument goes, so any multinational corporation that wants to stay in the game will locate some or all of its production processes there.

If that's all there was to it, China would never have to worry. But it is concerned right now -- for the first time, foreign investment in its manufacturing sector is starting to decrease. Why? It's because the line of logic just noted oversimplifies corporate mentality. Yes, in the short-run, a company might beat out its competitor by "racing to the bottom."

In the long-run, though, if it doesn't abide by labor regulations, adhere to environmental standards and invest in human capital -- that is, if it doesn't create those conditions in which workers can be productive on a continuous basis -- it'll lose.

And that's why companies are starting to withdraw their investments from China. Labor rights are minimal, hasty urbanization has poisoned its water and air and, perhaps more importantly, its work force is not all that it's cracked up to be.

Paradoxically, China faces a severe labor shortage. A fascinating new book, Fast Boat to China, shows how Chinese workers, fed up with mistreatment and lacking incentives to stay put, increasingly go "job hopping." Many employers are struggling to find and retain workers.

An interesting and important side note: Chinese engineers are not as competitive as some would suggest. Few know English or are business savvy and the vast majority are trained in schools where theory is favored over application. The result? According to the McKinsey Global Institute, only 10 percent of them can compete globally.

Given that China has been able to sustain a growth rate of 9 percent a year for the past two decades, why should this matter now? Simply, because China has accrued just about every possible benefit that it can from manufacturing (the industry that's anchored its growth since the 1970s) and has no choice but to look elsewhere for growth. It's no wonder that Beijing is suddenly stressing the importance of innovation.